Asian Development Outlook 2010: Fiscal deficit to miss target

Daily Times - ISLAMABAD: The Asian Development Outlook (ADO) 2010, a flagship report of the Asian Development Bank, said here on Tuesday that with higher than budgeted defence spending, the fiscal deficit target of 4.9 percent of the gross domestic product (GDP) for fiscal year 2010 would be missed and the government was targeting a deficit of 5.1 percent. But this too could be overshot in case of further shortfalls in tax and non-tax revenues. 

ADO 2010 further indicated that Pakistan’s economic prospects over the next two years were predicated on a successful completion of the current International Monetary Fund (IMF) programme by end-2010; a gradual improvement in the security situation, a phased reduction in electricity shortages as tariffs are rationalised and new power plants are commissioned, sustained implementation of fiscal reforms, particularly for tax and administration, a gradual economic recovery in the main trading partners and political stability. 

Growth in FY2010 is expected to modestly improve to 3.0 percent, backed by a slight recovery in manufacturing. This recovery, apparent in the first half of FY2010, reflects (among other factors) higher production for cement products for the local market and stronger domestic demand for automobiles. Textiles manufacturing, however, has continued to contract on account of lower cotton availability, electricity and gas shortages and poorer relative product competitiveness in the international markets. 

Agricultural growth in FY2010 is set to remain below the government’s target owing to lower than targeted production of most major crops, such as sugarcane and cotton. Production of wheat, a winter crop, will be less than the target of 25 million tonnes due to water and seed shortages, delayed sowing and higher input costs. Slower growth in agriculture, only a modest recovery in manufacturing and continued contraction in imports will all continue to drag down wholesale and retail trade. Following years of strong growth, telecommunications service providers, too, will need to consolidate operations (because of stronger competition and lower margins). Financial services could, however, perform better than in FY2009, as seen in slower growth in non-performing loans in the first half of FY2010, improving profitability of banks following higher spreads, and banks’ good capitalisation. The services sector overall will grow only moderately. 

GDP growth is expected to reach about 4.0 percent in FY2011, as private sector investment would pick up following gradual improvement in the security situation and fewer electricity shortages, and as public investment accelerates supported by an improved fiscal situation with value-added tax and other administrative tax reforms kicking in from July 1, 2010. Manufacturing growth is also expected to be stronger, as is agriculture’s (to a lesser degree) on the back of higher commodity prices. Higher real sector expansion with larger international trade volumes and an improving financial sector should catalyse further growth in services. 

The modest growth projected for FY2010 will make it hard for the Federal Board of Revenue to achieve its revenue target. However, higher oil and electricity prices (by way of larger customs revenues and sales tax receipts) will compensate somewhat for lower direct tax collections. 

Even with this larger fiscal deficit target, PSDP spending, although higher in the first half of FY2010 than in the same period in FY2009, will need to be reduced to accommodate higher defence spending, and will end up being lower than planned under the budget for FY2010. To contain current expenditure, the government in December 2009 announced austerity measures including reducing the number of federal ministries and slashing administrative expenses related to the offices of the president and the prime minister. It also set up a cabinet committee to restructure loss-making state-owned enterprises. For 2011, resource pressures will continue to weigh on the central government, owing to restructuring of shared taxes and responsibilities between the central and state governments. 

The key issue with the fiscal deficit remains its financing. A much larger than planned recourse to the domestic credit market to finance the deficit was required in FY2009 as external sources of financing dried up. The trend continued in the first half of FY2010. To this end, in the first eight months of FY2010, the government borrowed Rs 191 billion from commercial banks, although it kept borrowings from the central bank in check. 

In addition to bank financing, non-bank domestic financing of the deficit mainly through the National Saving Schemes jumped sharply. Such borrowings at end-2009 relative to end-2008 were Rs 300 billion higher. Continued high levels of domestic financing from bank and non-bank sources is unsustainable from the standpoint of fiscal stability and not desirable from the perspective of mobilisation of deposits by commercial banks, credit availability for the private sector, and growth. 

Continued recourse to such sources is partly due to the delays in foreign disbursements projected under the Friends of Democratic Pakistan (FoDP) aid group—a part of these unrealised disbursements is being temporarily made up by the IMF’s bridge-financing under the stand-by arrangement. The fiscal framework for FY2010 had relied heavily on such external resources for financing. The fiscal deficit target for the year might yet need to be scaled back if the projected FoDP disbursements are not realised. 

Inflation in FY2010 is expected to fall from its peak of the previous fiscal year due to the base effect, a sharp year-on-year decline in both food and non-food prices between July and October 2009, and a continued relatively tight monetary policy. But at a forecast 12.0 percent, it is still high. Looking ahead, domestic oil prices will increase in line with international prices with an automatic pass-through mechanism in place.